Richmond Fed’s Lacker critiques central bank’s new lending practices

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Jessica Sabbath

Richmond Federal Reserve President Jeffrey Lacker warned Thursday that the central bank’s recent policies on lending to securities firms could encourage risky behavior and lead to more credit crises.

“If people anticipate that in situations of financial stress the government or central bank will intervene in a way that limits private losses, then there is likely to be less interest in taking costly steps to avoid those situations,” Lacker said in prepared remarks during a speech at the European Economics and Financial Centre in London.

Lacker’s critique reveals dissension inside the Federal Reserve for some of its recent policies, including its $30 billion rescue of investment bank Bear Stearns in March, the first loan to nonbanks since the Great Depression. Federal Reserve Chairman Ben Bernanke defended that decision before Congress, arguing that its bankruptcy would have had a crippling effect on the U.S. market.

In his speech, Lacker argued that the Fed should intervene only during a “true liquidity crisis,” such as when a panic causes runs on banks that are still financially secure. However, he argued that lending when investors are questioning the value of their investments, “distorts economic allocations by artificially supporting the prices or some assets and the liabilities of some market participants.”

Lacker insisted that the Fed must make its policies clear on when it will interfere in the U.S. market.

In addition to saving Bear Stearns, the Fed has taken an unprecedented role during the recent credit turmoil, including expanding loans to financial institutions and trading Treasuries for riskier securities.

“This strikes me as a deeper form of moral hazard than what people usually have in mind. In times of financial crisis, the understandable central bank imperative is to alleviate the stress,” Lacker said during this speech. “But the expectations such actions engender could very well make future crises more likely.”
A transcript of the speech can be read here.

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